 | | IRA Choices: Roth IRA vs. Employer-
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Ideally, you should invest in both a 401(k) and a Roth IRA, since each offers unique tax benefits (discussed below). But sometimes a tight investment budget or other constraints may force a choice between the two.
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| If you face such a decision, start with a simple question: Does your company's plan match contributions up to a certain percentage of your salary? If the answer is yes, then the company plan is definitely the way to go. Note that a dollar-for-dollar match means you double your money instantly! If possible, invest up to the maximum percentage that qualifies for this benefit. By allowing your employer to deduct contributions before taxes are calculated, you'll also reduce your taxable income. | |
| The ability to invest with pretax dollars makes employer plans a safe bet even if your company doesn't match contributions. However, once you remove employer matching from the comparison, a Roth IRA becomes an equally compelling option—even though Roth IRAs don’t qualify for employer matching or pretax treatment, nor are they deductible on your tax return (as are traditional IRA contributions). | |
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That's because you pay into a Roth using post-tax dollars and, as result, you can take tax-free withdrawals at retirement. As long as you wait until age 59 1/2 to dip into your investment earnings and have had the account for more than five years, you'll never pay taxes or penalties. One limitation of the Roth is that your yearly contribution is capped at $ per year (or $ if you are 50 or older), but if your current budget's a little tight, that's not an immediate concern.
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Whatever you decide, plan on broadening your investments as soon as you have additional cash to sock away. If you've been contributing to your employer's plan up to the matched percentage, earmark the next $ for a Roth IRA. When you've maxed out there, consider putting more pretax dollars into your company plan. Conversely, if you started with a Roth, begin making pretax contributions to your company plan once you've hit the $ limit, or sooner if you want to spread the wealth.
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With a Roth 401(k), employers are permitted to make matching contributions on employees' designated Roth contributions. However, only an employee’s designated Roth contributions can be allocated to designated Roth accounts. The matching contributions made on account of designated Roth contributions must be allocated to a pretax account, just as matching contributions are on traditional, pretax elective contributions.
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| Even if you have no idea whether your income level and tax bracket in retirement will be higher or lower than they are now, the Roth 401(k) provides a good opportunity to hedge your bets: You'll pay some taxes now (on the Roth 401(k)) and some later (on the money you withdraw from your standard 401(k) plan). | |
| Before making a decision, you may want to consult with a financial or tax expert. They can help guide to the right solution and review the pros and cons of your options. | |
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